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Greenspan Backs Bank Reform

The approach to revamp Depression-era banking laws favored by the White House will "distort capital markets," Federal Reserve Chairman Alan Greenspan said Thursday.

In an appearance before the House Banking Committee, Greenspan repeated his support for ripping down the barriers between banking, insurance and securities, but he also warned that banks shouldn't engage in non-financial activities.

In his written testimony, Greenspan said nothing about monetary policy or the current state of the economy. He will give his semiannual Humphrey-Hawkins testimony on the economy to the committee and its Senate counterpart in two weeks.

Greenspan explicitly endorsed the bill (HR 10) sponsored by the committee's chairman, Rep. Jim Leach, R-Iowa. He didn't address an alternative bill (HR 665) sponsored by the panel's top Democrat, Rep. John LaFalce, D-N.Y., and endorsed by Treasury Secretary Robert Rubin on Wednesday. But Greenspan gave no ground in the

Rubin and Greenspan don't disagree about the need for reform, but have been at odds over how federal regulators should supervise the new integrated financial institutions envisioned by the reformers. The form of supervision will affect the corporate structure of the new companies.

The disagreement between Rubin and Greenspan led the White House to threaten to veto the bill. It languished in the Senate after narrow approval in the House last year. While the financial services industry is now (relatively) united behind the bill, its fate remains uncertain, particularly with the elevation of Sen. Phil Gramm, R-Texas, as chairman of the Senate Finance Committee.

If no legislation is approved, Citigroup (C) will be forced to divest either its insurance or its banking activities when its waiver expires.

Rubin wants non-banking activities, such as selling insurance or stocks, to be conducted in an operating subsidiary of the bank holding company, while Greenspan insists that these activities be separated from the bank in an affiliate of the financial service holding company. The bill Rubin endorsed allows for both types of structures.

Greenspan said the "new powers granted to financial service holding companies ... should be financed by the marketplace, not by instruments backed by the sovereign credit of the United States," he said.

"These activities, if conducted in bank subsidiaries, would accord banking organizations an unfair competitive advantage," Greenspan said, because federal deposit insurance acts as a subsidy for risky behavior.

Expanding the federal safety net (and subsidy) into new areas "could distort capital markets and the efficient allocation of both financial and real resources," the Fed chief said.

The same concern about expanding the safety net outside of banking has prompted Greenspan to lobby against allowing banks to become involved with non-financial activities such as manufacturing or commerce. "The Asian crisis last year highighted some of the risks that can arise if relationships between banks and commercial firms are too close," he said.

Rubin also has rejected close ties between banks and commercial firms, but the bill he endorsed Wednesday includes an exemption that would allow banks to own or control commercial activities that don't exceed 15 percent of their overall revenues. Rubin said he still had "serious concerns" about mixing banks and commerce.

Written By Rex Nutting, CBS MarketWatch

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